Question

Your company has earnings per share of $ 4.19. It has 1.2 million shares​ outstanding, each of which has a price of $ 42. You are thinking of buying​ TargetCo, which has earnings per share of $ 2.10​, 1.7 million shares​ outstanding, and a price per share of $ 26. You will pay for TargetCo by issuing new shares. There are no expected synergies from the transaction.

a. If you pay no premium to buy​ TargetCo, what will your earnings per share be after the​ merger?

b. Suppose you offer an exchange ratio such​ that, at current​ pre-announcement share prices for both​ firms, the offer represents a 25 %premium to buy TargetCo. What will your earnings per share be after the​ merger?

c. What explains the change in earnings per share in part​(a​)?

Are your shareholders any better or worse​ off?

d. What will your​ price-earnings ratio be after the merger​ (if you pay no​ premium)? How does this compare to your​ P/E ratio before the​ merger? How does this compare to​ TargetCo's premerger​ P/E ratio?

Answer 1

Solution:

a)Calculation of earnings per share after the​ merger

No. of shares to be isuued to Target co=($26/$42)*1700,000

=1,052,381

Combined Earning=$4.19*1.2 million+$2.10*1.7 million

=$8,598,000

No. of shares after merger=1200,000+1,052,381=2,252,381 shares

Earning Per share=$8,598,000/2,252,381

=$3.82 per share

b)Share Price of Target Company=$26*(1+0.25)=$32.50

No. of shares to be issued=($32.50/$42)*1700,000=1,315,476

No. of shares after merger=1200,000+1,315,476=2,515,476

Earning Per share=$8,598,000/2,515,476

=$3.42 per share

c)Earning per share after the merger is lower than my company's earning per share before merger.However earning per share after the merger is greater than the earning per share of Target Co.Thus for me situation become worse.

d)i)Price- Earning ratio after the merger

=Price of share/Earning per share

=$42/$3.82=10.99

ii)Price-Earning before merger

=$42/$ 4.19=10.02

Price Earning ratio after merger is higher than the Price Earning ratio before merger.

Target Company P/E ratio=$ 26/$2.10=12.38

Target company P/E ratio is greater than the P/E ratio of my company and combined company.